Pension deficits and the crucial role of pension trustees

Amongst all the heat of the current pensions debate, one truth has clearly emerged. Pension schemes are in effect a significant unsecured creditor. Trustees, who safeguard the interests of pensioners, therefore have a crucial responsibility to understand the underlying strength of their sponsoring employers. This is particularly important when companies and trustees agree a scheme funding recovery plan to make good a pension deficit.

The recovery plan sets the repayment schedule for a pension deficit - how much will be paid, in what form and over what period. The strength of the employer can be a major factor in influencing this and may mean a longer repayment period is acceptable to the trustees, possibly with less cash being paid into the scheme in the early years but more at a later date.

In order to understand the strength of the employer, it is important to take a broad view. Areas to assess include company structure, financial strength, future cash flows and market issues. Combining these creates an overall understanding of the strength of the “employer covenant”.

An obvious starting point is to focus on any company (within a group) that has the obligation to repay the deficit. To achieve this it is essential that the group structure is understood, a key component of which is identifying who the participating employers are and where they sit in the group structure.

The next step is to consider the financial strength of the participating employers. The balance sheet is a good starting point. However, as part of this process, any impairment of significant assets (e.g. an inability to realise full value from them in the event of insolvency) should be considered, as well as guarantees from other companies, assets offered as security and the current level of cash available to the scheme.

As part of understanding financial strength it may be appropriate to identify the payout to the pension creditor in an insolvency situation. In general, the higher the likely payout, the stronger the scheme’s position. Assets (or lack of them) are only part of the story. Future cash flows illustrate the ability of the employers to meet the required contribution rates and any schedule of repayment.

Finally, as part of looking at the future, one needs to understand the market issues. Demonstrating what the long term future looks like, the strength of the competition and understanding the industry and the employer’s position within it will be important for the trustees to assess the long term viability of the employer.

Once all of these areas have been investigated, an overall view of the strength of the employer can be formed. This is the starting point of any negotiation between trustees and employer.

A review of a company’s financial strength provides both trustees and employers with a common understanding of the issues and can be used as a means of identifying potential solutions. For the trustees who may not previously have had or needed to have, a detailed understanding of the employers financial strength, it is essential to allow them to make decisions about how to deal with a pension deficit through objective reasoning. For employing companies, it can be an effective way of communicating with trustees to establish a common view. This common understanding can then provide the platform for, if required, a joint approach to the regulator in case of a need to seek clearance for transactions, and communication with the scheme members around scheme funding in case of the need to seek clearance for the transactions.

These areas can be difficult for trustees and directors alike as they come to terms with the new pensions legislation and the potential conflicts between them. The experience and role of the professional advisory team, be they lawyer, actuary or financial can be crucial in arriving at a consensus or the way forward which has the support of all stakeholders of the company and the scheme.

Contact details
Email: Bruce Cartwright
Tel: +44 (0)131 260 4087